Anatomy of a Meltdown

For a good summary of the global economic crisis, and specifically, Ben Bernanke's role as Fed Chairman, I suggest taking a look at John Cassidy's recent article in The New Yorker. Here is the link.

Paul Ingrassia on The Auto Industry

Paul Ingrassia has a fabulous op-ed piece in the Wall Street Journal today about the auto industry. The title of the article is: The Auto Makers are Already Bankrupt. Ingrassia dispels a number of myths about the situation regarding the Big Three:

Myth 1: Bankruptcy is not an option.
Myth 2: Management changes would be pointless.
Myth 3: Bankruptcy means death.
Myth 4: Banning executive bonuses or requiring more fuel-efficient cars will save Detroit.
Myth 5: A GM-Chrysler merger will help save both firms.

This is definitely worth a read. Ingrassia has covered the auto industry for years, and he brings all that expertise to bear with a concise and insightful argument regarding a potential bailout.

General Motors and Bankruptcy

Business Week has a good, balanced article on the pros and cons of various scenarios for General Motors, as it pertains to a potential Chapter 11 filing. The article does a very nice job of pointing out how the government may actually step in to help facilitate an orderly Chapter 11 restructuring. In other words, the government might not execute a bailout to help GM avoid bankruptcy, but instead, would provide funds to help GM work through a Chapter 11 filing with the least amount of disruption to the rest of the economy. The article also points out that a successful Chapter 11 restructuring would put a great deal of pressure on Ford and Chrysler, as they would then face a domestic competitor with potentially much lower costs due to the restructuring. Thus, any bailout would have to consider how to deal with all three firms, not just GM.

The Financial Crisis and Groupthink

Robert Shiller had a very interesting article in the New York Times on November 1st about the global financial crisis. Shiller notes that a number of people did foresee oncoming troubles in the housing market and the financial system several years ago. However, he argues that the Federal Reserve downplayed the warnings being sounded by various people. Here is an excerpt from Shiller's article:

"But why weren’t the experts at the Fed saying such things? And why didn’t a consensus of economists at universities and other institutions warn that a crisis was on the way?
The field of social psychology provides a possible answer. In his classic 1972 book, “Groupthink,” Irving L. Janis, the Yale psychologist, explained how panels of experts could make colossal mistakes. People on these panels, he said, are forever worrying about their personal relevance and effectiveness, and feel that if they deviate too far from the consensus, they will not be given a serious role. They self-censor personal doubts about the emerging group consensus if they cannot express these doubts in a formal way that conforms with apparent assumptions held by the group."

I think Shiller has made a good point about social pressures for conformity that arise in groups and organizations, and that cause warning signs to be downplayed at times. However, I don't think the term groupthink technically applies here. Janis' work on groupthink tends to focus on pressures for conformity that arise within a team, such as the advisers to a President of the United States. In this case, Shiller is talking about a much more widespread pressure for conformity that extends beyond a team, and in fact, well beyond one organization.

A Vertically Integrated Clothing Retailer?

Business Week had an article about Zara, the Spanish apparel retailer, a few weeks ago. I actually just taught a case study about Zara, as I often do in my MBA strategy course. It's a fascinating company. While many clothing retailers outsource all production to low wage nations, particularly in Asia, Zara actually produces a substantial percentage of their clothes in their own factories in Europe.

Their vertical integration strategy is designed to enable them to react very quickly to market trends, and to produce fashionable clothes very quickly as part of their "fast fashion follower" strategy. The fast replenishment model and massive flexibility means Zara makes fewer mistakes, and when they do make a fashion error, it is less costly becuase they haven't ordered a huge shipment of the item from Asia. Because of this, they have fewer markdowns, and their markdowns tend to be smaller. That helps create higher operating margins.

Vertical integration always has its risks, but in this case, Zara has found a way to make it very profitable. It also has helped to create a unique business model that is very hard to imitate.

Should Disney Acquire Electronic Arts?

The Wall Street Journal on Saturday, in the Heard on the Street column, speculated on the potential value that could be created if Disney were to make a bid for Electronic Arts. The column focused, in particular, on the fact that EA's stock price had been knocked down recently due to less-than-expected earnings. It's an interesting notion, given the links between the video game publishers and the creators of entertainment content, such as movies and music. Over the past decade, firms such as EA have become more dependent on the film companies, because they have been licensing more and more content for their games. Many entertainment companies, including Disney, have been forward integrating or looking at forward integrating into video game development. The increased dependency on the film studios, as well as the threat of forward integration, both have put pressure on the margins at video game companies such as EA. Perhaps there is some possibility here for a vertical integration play. Of course, there are always downsides to vertical integration. How would Disney handle the possibility of licensing deals with other video game producers? How would EA handle licensing deals with other film studios? At this point, it seems as though the Wall Street Journal report is not indicating rumors of a deal in the works; it appears to simply be a suggestion that this deal might make sense. It will be interesting to watch if anything comes of it.

Bhide's New Book: The Venturesome Economy

I've been reading an advanced copy of Amar Bhide's new book, The Venturesome Economy: How Innovation Sustains Prosperity in a More Connected World. I must say that it is a thought-provoking manuscript that challenges much of the conventional wisdom about globalization and innovation. Bhide approaches the issue of globalization and innovation from a slightly different perspective than many other scholars, journalists, and pundits. For many years, Bhide has studied entrepreneurship. Thus, he approaches the issue of globalization and innovation by studying venture capital-backed businesses.

Bhide's main propositions are sure to prompt reaction and dissent from some quarters, but I find it refreshing to see him so eloquently argue that the United States and other western industrialized nations need not fear globalization. Here are a few of Bhide's propositions:

• "A nation's venturesome consumption - the willingness and ability of intermediate players and individual consumers to take a chance on and effectively use new know-how and products - is at least as important as, if not more important than, its capacity to undertake high-level research."
• "An increase in the world's supply of high-level know-how provides more raw material for mid-and ground-level innovations that increase living standards in the United States."
• "Techno-nationalist prescriptions to protect the U.S. lead in high-level know-how may do more harm than good by impairing the performance of the other players in the innovation game who use high-level know-how."
• Perhaps most importantly, Bhide argues that, "The development of scientific knowledge or cutting-edge technology is not a zero-sum game."

What makes the book fascinating to me is that Bhide approaches the issues of globalization and innovation from a very different perspective than traditional economists. As a business school professor, Bhide examines how venture capital-backed enterprises function. He's looking at the reality of young, innovative companies, rather than studying abstract conceptual models of the economy that are often based on assumptions that may not line up with reality. While economists clearly have much to offer to this debate about globalization, Bhide brings a new vantage point to the table. His book surely informs us in new ways, and it is certain to make us reconsider many of the key arguments being made in the popular press about globalization.

Slashing Prices on Blu-Ray Players

The Wall Street Journal has an article today about retailers slashing prices on Blu-Ray DVD players. The article is interesting, because it suggests that the retailers are not simply cutting price because of the down economy. They also are doing so because of fears of the oncoming move to digital downloads. They are trying to encourage adoption of the players, and thereby substantial purchases of Blu-Ray DVDs, before consumers begin to adopt video-on-demand and digital movie downloads in far greater numbers. In a sense, we have a race going on, with firms trying to make sure that we move from regular DVDs to Blu-Ray and then on to digital downloads in that order... the worry is that consumers might just leapfrog Blu-Ray, moving directly from normal DVDs to digital downloads and video-on-demand. The other major challenge in this market is that we may not have enough of a technological advantage to justify, in consumer's minds, making the upgrade to Blu-Ray... especially given the large inventory of normal DVDs that customers have in their homes.

GM and Chrysler - Merger, Government Intervention, or Bankruptcy

The Wall Street Journal has a front page story this morning outlining three possible options for General Motors and Chrysler: merger, government intervention, or bankruptcy. Some combination of the first two is also apparently an option. I understand the rationale for a merger, but I have my doubts. The potential for massive cost reduction synergies does exist here, but the key question is this: Can the two firms actually realize these synergies quickly enough to save the companies from bankruptcy? How complicated will the merger be, and does the complexity of integration take the firms' eyeballs off of actually running the business and trying to improve customer satisfaction? Merging two sick giants is not the typical path to success. As an investor, I would be very cautious about believing in the rapid synergy arguments that executives are likely to put forth as a rationale for the merger. For a cautionary tale, we need only look at the disastrous results for shareholders a decade ago when Daimler acquired Chrsyler.

Learning from Success and Failure

Many companies are conducting post-mortems these days. They are reviewing their failures, asking what went wrong, and trying to come up with corrective actions for the future. However, firms should remember that comparison helps to protect against spurious conclusions. When we study a single project, it becomes rather easy to jump to conclusions as to what factors contributed to that outcome. However, we may not have identified the correct cause-effect relationship; we can easiliy attribute a failure to the wrong causes and factors.

Research suggests that we learn more effectively if we compare successes and failures, rather than only examining our failures. Consider the work of Tel Aviv University scholars Schmuel Ellis and Inbar Davidi, who examined after-event reviews conducted by the Israeli military. They compared soldiers who conducted after-event reviews after successful and unsuccessful navigation exercises with soldiers who only reviewed failures. Ellis and Davidi found that soldiers who studied successes and failures performed better on subsequent missions than those who only studied failures. The two scholars argued that “contemplation of successful events stimulated the learners to generate more hypotheses about their performance.”

The implication is that, as firms study their failures these days, they should be systematically comparing the failures to past successes. Comparison and contrast will protect against spurious conclusions, and it will help refine their lessons learned.

The Balance Sheet as a Competitive Weapon

In finance, people talk about the "optimal" capital structure of the firm, i.e. the appropriate balance of debt and equity so as to minimize the cost of capital and maximize the value of the firm. However, some companies choose to maintain much less debt than they could afford to carry on their balance sheet. In fact, some firms not only carry little debt, but they maintain a hefty amount of excess cash as well. During good times, some investors dislike all that excess cash on a firm's balance sheet; they cite the opportunity cost, and they sometimes demand that the firm distribute the cash to shareholders through stock buybacks or dividends (sometimes because of fear that the management might squander the resources in pursuit of flawed diversification strategies or other ill-advised expansions).

Balanced against the opportunity cost, what does this conservatism get you, besides protection against financial distress during economic downturns? Most importantly, a strong balance sheet (low debt, excess cash) can become a competitive weapon for a firm. When other firms face distress, a company with a strong balance sheet can go on the offensive and put additional pressure on competitors. How can they do so? They might launch a price war, using the additional financial resources and flexibility to fund the discounting. That effort may enable the firm to increase market share in a downturn. They might also use the strong balance sheet to gobble up weaker competitors through mergers and acquisitions. Finally, they might use the resources to accelerate key investments in equipment, factories, R&D, and the like - investments that they know their rivals might not be able to match during the downturn.

Take the example of Wal-Mart in recent weeks. They just announced that they will be offering steep discounts on certain toys this holiday season. It appears that they are using their financial strength to try to increase market share at the expense of weaker rivals in the retail sector. Similarly, consider the examples of Wells Fargo and Bank of America in the financial sector. They appear to be using their strong balance sheets to make opportunistic acquisitions of weaker rivals during the financial crisis. These competitive moves would not have been possible without the flexibility provided by a strong balance sheet.

Cutting Costs

The Wall Street Journal has an interesting article today on how small businesses are finding ways to cut costs given the economic downturn. The article highlights some ways to reduce expenditures without cutting employees or service to customers.

In general, the philosophy that small businesses (actually all firms) should take in an economic downturn is that, "There is no such thing as fixed costs." In other words, businesses have to focus on overhead costs when volume plummets in an economic downturn. They must scale those down; otherwise, the average costs per unit will skyrocket as volume falls. Some good categories to focus on are energy, supplies, rent, and leases.

Will the Green Movement Become a Victim of the Global Financial Crisis?

The Dow ended down 369 points today, after having been down 800 points earlier in the day. The Dow finished below 10,000 for the first time in years on worries that the financial mess is spreading quickly to various international markets. With the global financial crisis deepening, one wonders about the impact on various companies. Today, I began wondering about the green movement. For the past few years, we have seen companies trying to become more environmentally conscious. Many firms tried to reduce their carbon footprint. You have to wonder, however, whether these firms will cut back on their environmental programs given the tough economic climate. Yes, some pro-environment moves by firms actually reduce their costs. However, other initiatives cost money in the short run, even if they do pay off over the long haul. Will firms scale back their environmental iniatives to try to preserve cash and bolster their financial position in this difficult economic environment? I think they will. It will be interesting to watch these developments.

Harley Davidson Advertising

I've always admired Harley Davidson's advertising, because it is so well-designed to represent the core values of the brand. Their latest print ad didn't let me down. It's an ingenuous ad, in that it BOTH stays consistent with the brand's core values, AND it lets the customer know that a Harley happens to get 50+ miles per gallon. Check out the ad below:

The Global Financial System

The current financial crisis provides a useful learning opportunity for all organizations as they consider their risk of a catastrophic failure of any kind - be it physical, technical, or organizational.

The global financial system is a good example of a complex system, as first defined and described by sociologist Charles Perrow. Complex systems are vulnerable to catastrophic failure, according to Perrow, if they have two attributes: high interactive complexity and tight coupling. By interactive complexity, he means that the system has many elements that interact in ways that are hard to predict and know in advance. By tight coupling, he means that different elements of an organizational system are highly interdependent and closely linked to one another, such that a change in one area quickly triggers changes in other aspects of the system. If we have learned anything over these past few weeks, it is that the global financial system exhibits high interactive complexity and tight coupling.

In a system with these attributes, large-scale failures result from a series of small errors and failures, rather than a single root cause. These small problems often cascade to create a catastrophe. Accident investigators in fields such as commercial aviation, the military, and medicine have shown that a chain of events and errors typically leads to a particular disaster. We see the same thing here with the global financial system. A problem that began with failures in the subprime mortgage market has cascaded to cause huge disruptions in many different parts of the global financial system and the economy more broadly.

Organizations of all kinds should take note. Do they operate systems with high interactive complexity and tight coupling? Could a small failure cascade to create a chain of errors that leads to major catastrophe? Every organization should look in the mirror and examine its vulnerability in light of these concepts.

Helping Employees Cope with Economic Turmoil

With turbulence and turmoil in the capital markets, employees in all industries are feeling a bit anxious these days, both about their net worth and their job security. For good reason, employees find themselves distracted from their day-to-day work. It's very easy for rumors to spread in the workplace about potential problems at a particular company, as well as the prospect of layoffs. The rumors and distractions can have a serious detrimental effect on employee productivity. How can managers cope with this problem?

First, they must communicate even more often than usual. They have to be very transparent about the economic condition of the firm. Managers also need to provide updates as to how external events are affecting the firm's business, i.e. how does overall economic growth correlate with the firm's profitability? How does Wall Street's woes affect the firm's profitability?

Second, they must go to great lengths to educate the workforce about the financial drivers of the business and the current state of the business. Many employees will need help understanding key financial metrics, as well as key causes of stock price changes.

Third, managers must be brutally honest about the state of the business. Just as top managers never like to be surprised by bad news, so too lower level employees don't want to be shocked. People will appreciate the candor.

Fourth, don't let the remedies come out in dribs and drabs (if possible). It's much better to assess the whole situation and announce the entire regimen of tough medicine required to cure the patient, rather than issuing one prescription after another over the course of many months. The initial pain will be great, but then the company can move on.

Finally, managers need to be very proactive about rooting out and disproving false rumors that pop up around the workplace. Letting fears, doubts, and misinformation linger can be very harmful.

Is Television Good for Kids?

The Wall Street Journal had a provocative article last week about new research exploring whether television might actually be good for children and families in some ways. Here is a short excerpt from the opening to the well-written, in-depth article:

"University of Chicago Graduate School of Business economists Matthew Gentzkow and Jesse Shapiro aren't sure that TV has been all that bad for kids. In a paper published in the Quarterly Journal of Economics this year, they presented a series of analyses that showed that the advent of television might actually have had a positive effect on children's cognitive ability."

The article goes on to cite the findings from the study:

"The variation Mr. Gentzkow and Mr. Shapiro exploited was the timing of the introduction of TV into different cities. Television began taking off in the U.S. in 1946, after a wartime ban on TV production was lifted. But the Federal Communications Commission stopped granting new commercial television licenses from September 1948 to April 1952 while it made changes in allocating broadcast spectrum. There was a long lag between when some cities got television and when others did. The economists then looked at results of a survey of 800 U.S. schools that administered tests to 346,662 sixth-grade, ninth-grade and 12th-grade students in 1965. Their finding: Adjusting for differences in household income, parents' educational background and other factors, children who lived in cities that gave them more exposure to television in early childhood performed better on the tests than those with less exposure. The economists found that television was especially positive for children in households where English wasn't the primary language and parents' education level was lower."

Now, of course, there are limits to how much we can generalize from this study, as the article points out. The findings are from a different era, when the content on television was quite different (i.e. far less trashy). Moreover, they are seeing positive effects specifically in households where English was not the first language, i.e. immigrant households. Yet, I find the research intriguing, because I was raised in a household where English wasn't the first language. My parents came over from Italy just three years before I was born. We did watch a fair bit of television when I was young. Since my parents didn't speak much English at the time (or at least it was broken English), the television may have been beneficial in helping me learn the language. I think it's at least plausible that it could have had some positive effect. Having said that, I don't think my kids are in the same situation. They have plenty of other avenues for learning to speak, read, and write English, and they don't need the television to help them!

Can winning sports teams make us more productive employees?

The Boston Globe had an interesting article last week on the topic of whether a winning team can actually enhance the financial well-being of its fans. It cites research by economist Michael Davis and psychologist Christian End. The article explains the study:

"A winning NFL football team increases the incomes of the people who live and work in its hometown by as much as $120 a year. And while the study doesn't identify exactly what causes the boost, the authors point to psychological literature suggesting that winning fans are at once harder workers and bigger spenders. In short, buoyed by the team's success, we work longer hours, take bigger risks, and shop more avidly, all of which helps the local economy."

I'm not at all sure that this psychological impact on a team's fans merits the large public subsidies often given to sports teams to build new stadiums, but it is certainly fascinating research about how our moods might affect our productivity as workers.

Guest Post - Leading from the Wings

Leading From the Wings

This post was contributed by Heather Johnson, who writes on the subject of California teaching certificate. She invites your feedback at heatherjohnson2323@gmail.com

Walking down memory lane, I recall a friendly basketball match that I played against the sophomores as a freshman in college. I was new, and so were the others on my team. We had not yet had time to get to know each other well, the strengths and weaknesses that each of our games brought out. So when it came to choosing a captain, a teammate was chosen at random. But as the game progressed, we seemed to be drifting like a rudderless boat thrown at the mercies of a wild sea. We had no game plan, no team work, and most of all, no commitment.

After a poor show in the first half, I decided to take control of things even though I was not the designated leader. The game we’d played so far had offered me a peek into both the strengths of my teammates and the weaknesses of my opponents. Armed with this insight, I outlined plays and strategies for the second half during the interval. We didn’t win that day, but the loss was far from humiliating. We had redeemed ourselves during the latter part of the match.

I learnt a valuable lesson in leadership that day – it’s not just designated leaders who must lead all the time. Team members with a sense of responsibility and an innate aptitude for management are equally at fault if the team goes astray. In fact, they are more to blame, because they know what they must do and yet they fail to do it for various reasons. They may fear alienating or offending the appointed leader, they may be too lazy to take on the onus of leading the team, or they may be too shy and apprehensive to come forward with their ideas.

We can use these points to define a true leader – one who knows what needs to be done and is not afraid, reluctant or timid to do it in a way that is appreciated and admired by everyone else on the team. A leader guides rather than controls, listens rather than talks all the time, works with the team rather than make them do all the work, shares credit with everyone and takes blame alone, and thinks things through before actually implementing them. A good leader knows that the best way to motivate is through encouragement and not fear and that praise is more important than recriminations.

A true leader does not ask for credit for a job well done, which is very important in the kind of scenario I outlined above. Leadership driven by a love for the spotlight is as fleeting as a shooting star – a flash of brilliance reduced to ashes and dust. Leadership must focus on the goals at hand and take the right decisions using the right people to reach those goals in the most efficient way possible. Publicity lets others know that you’re a good leader, but fame is a fickle friend that deserts you the moment you make a mistake. Leadership that’s driven by a love of achievement alone is the kind that’s head and shoulders above the rest, the kind that lasts a lifetime, no matter where the cameras are focused. You don’t have to be the star of the play to feel a sense of achievement; it’s infinitely better to be the director in the wings who pulls the strings and calls the shots. After all, no matter how entertaining the puppets are, there’s no show without the puppeteer!

7 Ways to Fail Big

Paul Carroll and Chunka Mui have a provocative article (Seven Ways to Fail Big) in this month's issue of Harvard Business Review. They studied the 750 of the most significant business failures from 1981-2005, and they identified some key lessons from those cases. While one might quibble with their methodology or even with some of their conclusions, it certainly makes for interesting reading. The article should be commended for not only providing a list of the mistakes that were most often made, but also for offering some suggestions on how to avoid these catastrophes. I especially liked their two sidebars titled "The Devil's Advocate" and "Questions Every Company Should Ask." I think executives would be well-served to consider the techniques presented in those portions of the article.